budgeting

budgeting

Harvard Business School 9-185-061 October 25, 1984 Citibank Indonesia In November 1983, Mehli Mistri, Citibank’s country manager for Indonesia, was faced with a difficult situation. He had Just received a memorandum from his immediate superior, David Gibson, the division head for Southeast Asia, informing him that during their Just-completed review of the operating budgets, Citibank managers at corporate had raised the SE-Asia division’s 1984 after-tax profit goal by $4 million. Mr. Gibson, in turn, had decided that Indonesia’s share of this increased goal should be between $500,000 and $1,000,000.

Mr. Mistri was concerned because he knew that the budget he had submitted was already very aggressive; it included some growth in revenues and only a slight drop in profits, even though the short-term outlook for the Indonesian economy, which was highly dependent on oil revenues, was pessimistic. Mr. Mistri knew that to have any realistic expectation of producing profits for 1984 higher than those already included in the budget, he would probably have to take one or more actions that he had wanted to avoid.

One possibility was to eliminate (or reduce) Citibank’s participation in loans to prime government or private enterprises, s these loans provided much lower returns than was earned on the rest of the portfolio. However, Citibank was the largest foreign bank operating in Indonesia, and failing to participate in these loans could have significant costs in terms of relations with the government and prime customers in Indonesia and elsewhere. The other possibility was to increase the total amount of money lent in Indonesia, with all of the increase going to commercial enterprises.

But with the deteriorating conditions in the Indonesian economy, Mr. Mistri knew that it was probably not a good time for Citibank to increase its exposure. Also, the government did not want significant increases in such offshore loans to the private sector at this time because of their adverse impact on the country’s balance of payments and services account. So, Mr. Mistri was contemplating what he should do at an upcoming meeting with Mr. Gibson. Should he agree to take one or both of the actions described above in order to increase 1984 profits?

Should he accept the profit increase and hope that the economy turned around and/or that he was able to develop some new, hitherto unidentified sources of income? Or should he resist including any of the division’s equired profit increase in his budget? CITIBANK Citibank, the principal operating subsidiary of Citicorp, was one of the leading financial institutions in the world. The bank was founded in 1812 as a small commercial in New York City, and over the years it had grown to a large, global financial services intermediary. In 1983, the bank had revenues of almost $5. billion and employed over 63,000 people in almost 2600 locations in 95 countries. This case was prepared by Assistant Professor Kenneth A. Merchant as a basis for class discussion rather than to illustrate either effective or ineffective handling of an dministrative situation. Copyright 1984 by the President and Fellows of Harvard College. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means??”electronic, mechanical, photocopying, recording, or otherwise??”without the permission of Harvard Business School.

Distributed by HBS Case Services, Harvard Business School, Boston, MA 02163. Printed in U. S. A. 1 This document is authorized for use only in International Accounting, FMlB4 FMlB5 (A) by Tiffany Rasmussen at Hult International Business School from November 2013 to August 2014. 185-061 Citibank’s activities were organized into three principal business units: institutional banking, individual banking, and the capital markets group.

The Institutional Banking units provided commercial loans and other financial services, such as electronic banking, asset-based financing, and foreign exchange, to corporations and governmental agencies around the world. The Individual Banking units, which operated in the U. S. and 18 other countries, provided transactional, savings, and lending services to consumers. The Capital Markets Group served as an intermediary in flows of funds from providers to users. With a staff of 3500, this group was one of the largest investment banks in the world. Exhibit 1 shows the relative size of these activities, and Exhibit 2 shows a summary corporate organization chart. ) MEHLI MISTRI Mehli Mistri, Citibank’s country corporate officer for Indonesia, Joined Citibank as a management trainee in the Bombay office in 1960, Just after finishing a B. A. degree in Economics from the University of Bombay. Between 1960 and 1964, Mehli gained experience in a number of assignments in the Bombay office, and in 1965 he transferred to New York to work in the credit analysis division.

He returned to Bombay in 1966, and then became manager of Citibank branches in Madras (1968), Calcutta (1969-71), New Delhi (1972), and Beirut (1973). In 1974, he was promoted to regional manager with responsibility for five countries in the Middle East (Turkey, Syria, Iraq, Jordan, Lebanon), and he held that position until 1979 when he was appointed the country head of Indonesia. He remained in that position up until the time of this case. In 1982, Mehli attended the Advanced Management Program at the Harvard Business School.

CONTROL OF INTERNATIONAL BRANCHES Citibank managers used two formal management processes to direct and control the ctivities of the corporation’s international branches: reviews of sovereign ris for each location and reviews of operating budgets and accomplishments. Sovereign Risk Limits Each year Citibank management set sovereign risk limits for its international k limits branches based on country risk analyses. The term sovereign risk actually refers to a wide spectrum of concerns that would impair the bank’s ability to recapture the capital it invested in foreign countries.

These included macroeconomic risk, foreign exchange controls that the government of the host country might employ that would ake it difficult for clients to pay their obligations, or, in the extreme, expropriation of assets. Once Citibank had opened a given branch, however, it intended to keep it open, so the reviews of sovereign risk were concerned only with setting limits of the amount of money a branch could lend in foreign currency. The sovereign risk review process started in mid-year with the country manager proposing a sovereign risk limit.

This limit was discussed with division and group managers and was finally approved, on a staggered time schedule, by a senior international specialist on the corporate staff. The foreign currency lending limit for Indonesia had grown substantially as the branch had grown. The sovereign risk limit set during these reviews was an upper guideline. When the economic conditions in a country changed in the period between sovereign risk reviews, country managers sometimes chose to operate their branches with self-imposed sovereign risk limits that were below the limits set by management in New York.

Corporate managers encouraged this behavior because they knew that the managers on site often had a better appreciation of the risks in the local environment. 2 Budgeting Budgeting at Citibank was a bottom-up process which started in July when eadquarters sent out instructions to the operating units describing the timing and format of the submissions and the issues that needed to be addressed. The instructions did not include specific targets to be included in the budget, although it was widely recognized that the corporation’s combined long-term goals were approximately as follows: Growth: 12-15% per annum Return on Assets: 1. 5% (125 basis points) Return on Equity: 20% The above norms were established for Citibank as a whole, but a number of international branches, including Indonesia, traditionally exceeded these norms, and hese entities often established their own targets at higher levels. At the time the operating managers received the budget instructions, they would have the results for half the year (through the end of June), and in the period from July until the end of September, they would prepare a forecast for the remainder of the current year and a budget for the following year.

The starting point for the preparation of the budget was projections about each of the major account relationships, and discussions continued until the summation of the account relationship projections could be reconciled with the desired profit center bottom ine. Then costs were considered. The budget submission form included all the line items shown in Exhibit 3. In some past years, the bank had prepared two- and five- year projections, but the numbers were seen to be very soft and not very useful.

Formal reviews of the annual budgets were held according to the following schedule: Level of Review Timing Division Group Institutional Bank end of September mid October end of October If the sovereign risk review for a particular entity had not yet been held, the budgets were submitted with the assumption that the risk limits would be approved as submitted. If this assumption proved to be incorrect, the budget had to be revised before it was incorporated in the corporate consolidated budget. Performance was monitored and compared against budget each month during the year. Every quarter a new forecast for the remainder of the year was made.

Whether these were reviewed formally by division managers varied widely, depending on the division manager’s style. Some managers held relatively formal on-site reviews of performance and budget revisions, and others communicated only by mail or by telephone. Mr. Mistri was very comfortable with the review processes: Every level of management has a role to play, and there is a lot of horsetrading and give and take in the budget review processes. Usually there is more revision of the numbers at lower management levels, but revisions do not necessarily mean increased profit goals.

I have seen cases where the division head thought the country head was being too aggressive and he asked for the budget to be lowered. 3 The managers sitting further away are more objective, and the review processes are consultative, collegial, and constructive. Budgets were taken very seriously at Citibank, not only because they were thought to nclude the most important measures of success, and also because incentive compensation for managers at Citibank was linked to budget-related performance. For a country manager, incentive compensation could range up to approximately 70% of base salary, although awards of 30-35% were more typical.

Assignment of bonuses were based approximately 30% on corporate performance and 70% on individual performance, primarily performance related to forecast. The key measures for assessing both corporate and international-branch performance were growth, profits, return on assets, and return on equity. However, in the analyses of individual performance for the purposes of assigning incentive compensation, considerable care was taken to differentiate base earnings from extraordinary earnings (or losses) for which the manager should not be held accountable.

CITIBANK IN INDONESIA Indonesia was a relatively young country; it achieved independence only in 1949 after many years of being a Dutch colony. Citibank had operated in Indonesia only since 1968 when President Suharto allowed eight foreign banks to set up operations in Jakarta. From the point of view of the Indonesia government, the role of the foreign anks was to help develop a young economy by transferring capital into the country, establishing a modern banking infrastructure, attracting foreign investment, and developing trained people. The foreign banking community operated in Indonesia with some important restrictions.

The most serious constraints were that foreign banks were not allowed to open branches outside the Jakarta city limits, and local currency loans could be made only to corporations with headquarters and principal operations within the Jakarta city limits. But, on the other hand, the Indonesian government did not require ny local ownership of equity, it set no lending quotas for the banks (e. g. , requirements to lend certain amounts of money to certain types of businesses at favorable rates), and it valued and maintained a free foreign exchange system.

In explaining the goals of the government with respect to the foreign banks, Mr. Mistri commented: We consider ourselves priviledged to be in Indonesia. We realize that the country wants to develop economically, and we know that the government sees us in the role of a development and change agent, attracting and developing not only capital, but lso new financial products, services and techniques and trained managers and professionals for the financial services industry. The government also expects us and other international banks to participate in extensions of credit to both the public and private sectors.

Citibank and the other foreign banks were interested in operating in Indonesia for several reasons: (1) to serve their international and local customers, (2) to assist in the economic development of the country, and (3) to share in the potential for profits and growth the Indonesian economy offered. The Indonesian economy had remendous potential: the country was the fifth largest in the world in terms of population, and the economy had shown excellent growth for many years, as the fgures shown in Exhibit 4 illustrate.

The country was rich in raw materials, particularly oil and tin, and the Indonesian government was very interested in developing the country’s industrial activities. In 1983, Citibank’s Indonesian operation included activities in each of the three major lines of business??”institutional, individual and capital markets. Mehli Mistri was the Country Corporate Officer, and s such, he was the primary spokesman for all of Citibank’s activities in Indonesia. His prime line responsibility, however, was the Institutional Banking activity which provided by far the 4 greatest proportion of revenues and profits.

Other individuals headed the Individual Banking and Capital Markets activities in Indonesia, and they reported through separate management channels (see Exhibit 5). Since its inception, Citibank’s Indonesian operation had been very successful. Its growth paralleled that of the Indonesian economy. THE SITUATION IN 1983 In 1983, Mr. Mistri was concerned about the risk-return ratio in his branch. He felt omfortable with Indonesia’s long-term prospects, but the country, which was highly dependent on oil revenues, had slipped into a recession when oil prices decreased significantly.

His concern was as to whether the government would take strong enough steps to correct its balance-of-payments problem. Inside the bank, Mr. Mistri was faced with a problem of high staff turnover. High turnover had been a problem for Citibank for many years because the bank provided its people with training that was recognized as probably the best in Indonesia, and local financial institutions had lured many Citibank people away with generous offers.

This had happened so often that Citibank had been given labels such as “Citi- university” and “Harvard-on-wheels,” and the government often held Citibank up as an example of how foreign banks could (and should) supply trained professionals to the country. To attempt to retain more of its trained people, Citibank had recently increased its compensation levels, but some people in the branch felt that the bank could not compete on the basis of salary because of its desire to be profitable, its limited domestic branch network, and significant career opportunities elsewhere.

The year 1983 was particularly difficult from a staff turnover standpoint, as the losses included Mr. Mistri’s chief of staff and two senior officers. In mid-1983, the average account manager experience was under two years, and there were three unfilled slots at management levels. Mr. Mistri knew that the inexperience and people shortages in the branch were also serious constraints to growth. Given these significant problems, Mr. Mistri thought that the budget he submitted, which projected modest growth, should be considered as aggressive. He wanted to submit an aggressive budget because … are an aggressive organization. We like to stretch because we feel the culture of our corporation and the will and desire of our people to succeed and excel can make up the difference. In reflection of the fast-changing uncertainties in the economy and the personnel problems, however, Mr. Mistri decided to operate with a self-imposed sovereign risk limit that was somewhat lower than that which that had been formally approved by management in New York. He knew that his responsibility was as much to manage risk as to generate profits. In late October, 1983, however, the budget for the whole

Institutional Bank was reviewed at headquarters, and the consolidated set of numbers did not show the growth that top management desired. This led management to suggest some budget increases, and these increases presented Mr. Mistri with the dilemma described in the introduction to this case. 5 Exhibit 1 Selected Citicorp Financial Data – 1983 (dollars in millions) Citicorp Consolidated Revenues Net Income Return on Shareholders Equity Return on Assets $ 5,883 $ 860 16. 5% Institutional Bank $ 2,896 $ 758 22. 0% Individual $ 2,380 $ 202 17. 7% . 69% Capital Markets $ 587 $128 32. % SOURCE: 1983 Citicorp Annual Report Exhibit 2 Partial Citibank Organization Chart Exhibit 3 Line Items on Budget Submission Form REVENUE/EXPENSE Local Currency NRFF Foreign Currency NRFF Allocated Equity NRFF BAD DEBT RESERVE EARNINGS NET REVENUE FROM FUNDS Exchange Translation Gains/Losses Trading Account Profits Trade Financing Fees Securities Gains/Losses Fees, Commissions & Other. Rev. Affiliate Earnings Gross Write-offs Gross Recoveries Loan Provision Excess Direct Staff Expenses Direct Charges Other Direct Expenses Allocated Processing Costs Minority Interest Other Allocated Costs Matrix Earnings EBIT Foreign Taxes U.

S. Taxes PROFIT CENTER EARNINGS Equity Ad]. – Translations Placements (AVG. ) Total staff (EOP) Total Non-performing Loans-EOP Rev. /Non-Performing Loans Avg. Total Assets – Lcl Curr. Avg. Total Assets – Fgn Curr. Allocated Equity LOCAL CURRENCY – AVG. VOL. Loans Sources-Non-lnterest Bearing Sources – Interest Bearing FOREIGN CURRENCY – AVG. VOL. END OF PERIOD (EOP) Past Due Obligations Interest Earned Not Collected Assets 8 Exhibit 4 Indonesia Gross Domestic Product (billions of rupiahs) Year 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 Gross Domestic Product 2,097 2,718 3,340 3,672 4,564 6,753